Patent Trolls Are Killing Startups — Except When They’re Saving Them

Ditto co-founder and CEO Kate Endress. Photo: Ditto

Kate Endress was living the startup dream. Two years out of Stanford’s business school, she was running a website, Ditto, that offered a way of trying on glasses without actually trying them on, and the operation was on the verge of raising its first round of venture capital.

Then came the lawsuit. Wellpoint, the owner of 1-800-Contacts and Glasses.com, sued Ditto for patent infringement. “Just like that, we were faced with an ‘injunction’ threat from a $25 billion competitor,” Endress remembers. “I was terrified our years of hard work were for naught.”

Her account of Ditto’s ongoing tangle with a patent-wielding behemoth arrives as part of a new survey published by the New America Foundation’s Open Technology Institute, a not-for-profit organization that seeks to promote a more open exchange of ideas in the world of digital technology. The study details how the startup world is affected by so-called patent trolls — companies that use patents merely to attack other companies — and as you might expect, it’s not pretty reading.

For the study, conducted earlier this year, Santa Clara University School of Law Professor Colleen Chien surveyed about 300 venture capitalists and venture-backed startups. Seventy-five percent of the VCs said their portfolios had been on the receiving end of patent actions, and that rate rose to nearly 90 percent among VCs that deal specifically in digital tech. The rate among individual startups surveyed was much lower — 20 percent — but the impact on those that were targeted was sometimes severe.

‘Just like that, we were faced with an ‘injunction’ threat from a $25 billion competitor. I was terrified our years of hard work were for naught’

— Kate Endress

The current patent system can severely hamper the growth of software startups here in the U.S., but as this new study arrives, Congress is considering changes to the system, and some startups are finding new ways of fighting back. In their ongoing effort to stay alive, Endress and Ditto are taking a rather counterintuitive approach to the Wellpoint suit. They’ve enlisted the help of someone derided by his critics as a patent troll pioneer.

In her account, Endress alleges that Wellpoint filed suit with a patent that it purchased only after seeing Ditto’s tech — tech for which Ditto itself was seeking patents. “I can only speculate that they fear that the patents we filed (which take years to issue!) will become a weapon towards them down the road,” she writes as part of the Open Technology Institute study. “But if they would have just called me before filling a lawsuit against us, they would know we applied for those patents for defensive purposes, not offensive ones.”

In other words, she insists that Ditto is only interested in defending its turf, not in attacking competitors, as Wellpoint has done. This is a common stance in Silicon Valley — Twitter made such a policy explicit last year — but it only goes so far in deterring suits.

In response to questions from WIRED, 1-800-Contacts blasted Endress’ claims. “Like most other companies operating a business that depends on technology, 1-800-Contacts purchased this patent for a reason — the patent potentially covered what the business was doing so the patent either needed to be licensed or purchased,” the company says, pointing out that the patent was granted in 2006, though the company purchased it in 2012. “Ditto could have licensed or purchased the same patent, but chose to ignore it and launched their website with an infringing virtual try-on feature anyway.”

1-800-Contacts also says it tried to reach a licensing agreement or some other “amicable” arrangement with Ditto. “But instead of responding to our offer, Ditto has spent time and energy engaging in online discussions and issuing an inaccurate and misleading press release,” the company says.

Such “he said-she said” sniping is typical of patent cases. Not so typical is the strategy Ditto has undertaken to sustain its fight against the suit. The company has called in Erich Spangenberg, the founder of IPNav, an outfit that says it’s in the business of “full service patent monetization.” His opponents describe him as “the most notorious patent troll in America.”

When Ditto found its back against the wall, Endress writes, she and Spangenberg made a deal. Spangenberg offered to handle Ditto’s case and pay for all legal expenses in exchange for equity in the company worth about half of what Endress believed it would cost Ditto to fight the case solo. She says her initial reaction to Spangenberg was the same derision felt by many in the software industry. But in her situation, his offer made good business sense.

“Erich Spangenberg sees this as an opportunity to get equity in great startups for doing what he does best. So until the day that we have a properly functioning patent system, his solution is my best option,” Endress writes. “When a huge company puts a target on your back, sometimes you need to powerful friends to have a shot at surviving.”

Before Endress connected with Spangenberg, she says, she went so far as to explore selling Ditto. But would-be buyers were valuing the company at $3 million to $4 million less because of the lawsuit — a big hit for a startup still trying to find its feet. In April, says Ditto co-founder and chief technology officer Sergey Surkov, the company laid off four of its 15 employees to reduce its spending and conserve money for legal expenses. (Endress is on her honeymoon, according to Surkov, and wasn’t available to comment for this story.)

Under such duress, no one should fault any single business or individual for the choices they make in a patent fight, says Julie Samuels, a staff attorney at the Electronic Frontier Foundation. “To ask someone who’s facing a patent troll to do what’s best for the world, which is to fight back or make a lot of noise, is often asking them to do something that’s against their short-term interest,” Samuels says. “The systemic problem is different than the problem that any one company finds itself facing.”

Samuels and a colleague blogged about the suit against Ditto shortly after it was filed, describing the case as an abusive attempt to squelch competition. But 1-800-Contacts contends that the EFF is biased because three of its advisory board members work for the law firm representing Ditto.

‘Though partnering with non-practicing entities to monetize patents can be beneficial to companies as well, the benefits do not appear to offset the harms’

— Colleen Chien

For casual observers who don’t follow intellectual property disputes, the whole idea of a system that enables patent trolling is still astonishing. In the mythology of American innovation, inventions aren’t just words and diagrams buried in legal documents. They’re things we make. Patent-trolling seems to directly violate the basic premise of inventing: People who don’t make anything suing people who do.

But the system also seeks to protect startups. In theory, the ability of startups to secure their ideas while still in the design stages should give them the breathing room they need to make the thing they envision.

Ironically, startups themselves sometimes benefit from the very system that supposedly thwarts their ability to innovate. If a startup successfully secures a patent, it now has an asset that it can leverage, sometimes selling it to firms that could then turn around and use that patent to troll others. In such a marketplace, the argument goes, non-practicing entities, or NPEs — aka patent trolls — effectively act as market makers that allow startups to quickly realize real cash value from their intellectual property.

The Open Technology Institute’s survey found that about 5 percent of startups were able to realize such value from their patents, but that rate that pales compared to those that suffer from patent actions taken against them. The study’s results suggest that any such revenue theoretically provided to startups by their own patents is then offset by the chilling effect that patent lawsuits — or even the fear of such suits — can have on companies still in their fragile early stages.

“Though partnering with NPEs to monetize patents can be beneficial to companies as well,” Chien writes, “the benefits do not appear to offset the harms.”

In Congress, patent reform has become one of those rare causes to generate genuine bipartisan support. The SHIELD Act and the STOP Act are designed to curb frivolous lawsuits and reform the system to encourage doers rather than suers. But waiting for Congress to act on anything is clearly bad business strategy. Until then, the patent system will likely continue to breed strange bedfellows.